Last year saw a slowdown in the chip sector due to the Japan earthquake and tsunami which affected production, and difficult economic conditions in Europe and the U.S. that were hurting demand. The greatest sector-wide risk in the highly cyclical semiconductor space remains the macroeconomic environment. Global GDP growth spurs semiconductor industry growth, and lately there have been signs of a recovery. Around December 2011, orders and billings of chip companies started to improve, partly because of strong demand for semiconductors in mobile devices.
Although the chips produced by semiconductor companies are usually non-interchangeable, I expect some consolidation in the semiconductor space going forward, in particular in the analog and industrial segments. Last year’s biggest deal in the chips sector was the $6.5 billion acquisition of National Semiconductor by Texas Instruments (NASDAQ:TXN) at a 78% premium. It made Texas Instruments the world’s largest semiconductor maker after Intel (NASDAQ:INTC) and Samsung Electronics.
A related deal saw Applied Materials (NASDAQ:AMAT), the biggest producer of chipmaking equipment worldwide, take over Varian Semiconductor Equipment Associates for $4.9 billion, mainly to add technology for chips used in mobile devices. Applied Materials is one of the semiconductor industry’s most acquisitive companies, with 13 announced deals over the past six years. Varian was its biggest acquisition, and followed a seven-year courtship.
Apart from the major semiconductor players mentioned above, other possible merger partners include On Semiconductor (ONNN), which was buying smaller companies at a fast pace, although it has lately been running out of cash and was hit by the floods in Thailand. Its market cap is now $4.15 billion, similar to that of some of the potential targets.
Oracle (NYSE:ORCL), which is in another league with a market cap of $145 billion, has said that it might buy semiconductor companies. It has $15 billion of net cash, which is also a factor that will encourage buying by some other technology companies. Apple (NASDAQ:AAPL), which is valued at $563 billion by the market, has no debt and the most cash among technology companies with over $30 billion, but it might not necessarily want to vertically integrate with a semiconductor firm.
The following companies are potential targets:
Advanced Micro Devices (NASDAQ:AMD), which has a market capitalization of $ 5.73 billion, operates as a semiconductor company worldwide. It designs, develops and sells microprocessor products, such as central processing unit (CPU) and accelerated processing unit (APU) for servers, desktop personal computers (PCs), and mobile devices. Advanced Micro Devices recently completed the $334 million acquisition of SeaMicro, a privately held start-up that targets the cloud computing space and in particular mega data centers owned by the companies like Google (NASDAQ:GOOG) and Yahoo (YHOO), for which the cost of power and space are several times the cost of the servers themselves over the product life cycle. Acquiring SeaMicro is a stab at Intel, since SeaMicro only uses Intel chips at the moment and is Intel's primary partner in the microserver segment. In my analysis, Advanced Micro Devices would be a fairly inexpensive acquisition for an Intel-competitor as it trades at 12.24 times trailing and 9.93 forward earnings. It has a 7.10% operating margin and 7.48% profit margin, which is relatively modest compared to some of its competitors.
ARM Holdings (ARMH) designs microprocessors, physical IP and related technology and software; and sells development tools to enhance the performance of high-volume embedded applications. The $13 billion U.K. firm licenses and sells its technology and products to electronics companies and licenses and sells development tools directly to systems companies. ARM Holdings is one of the most expensive takeover targets in the semiconductor industry with a trailing price-to-earnings ratio of 73.23, but it has an impressive operating margin of 30.94% and profit margin of 22.90%. Its chips help power mobile handsets including Apple’s iPhone, and Apple is considered by some as a possible suitor.
Cirrus Logic (CRUS) is the smallest of the group with a market cap of $1.58 billion. It develops high-precision analog and mixed-signal integrated circuits (ICs) for audio and energy markets worldwide. Cirrus' chips control the power and sound in electronics. Every Apple product uses them, and Apple is a large and increasing part of Cirrus revenue. Cirrus is therefore also considered a potential Apple target. The company is also quite cheap with a trailing P/E of 10.21 and a forward P/E of 15.53. It has an operating margin of 17.75% and a high profit margin of 41.11%.
Jabil Circuit (JBL) is a $5.32 billion technology hardware assembler. It offers electronics and mechanical design, production, product management and after-market services. It has recently seen healthy growth in the core manufacturing business but also in energy efficiency and the health care sector. Jabil could be had at a discount: It is currently valued at 12.89 times trailing and 8.54 forward earnings by the market. However, Jabil’s profitability is also the lowest of the five potential targets, with an operating margin of only 3.74% and a profit margin of 2.52%.
Marvell Technology Group (MRVL) designs, develops and markets analog, mixed-signal and digital signal processing and embedded microprocessor integrated circuits. It specializes in chips for platforms such as high-volume storage solutions, mobile and wireless, networking, consumer and green products. The added attraction for a potential buyer is that the $9.3 billion company is debt-free and has $2.25 billion in cash. TRC Capital recently made a mini-tender offer for up to 6 million of Marvell shares, or about 1% of its outstanding stock, at $15 per share, below its current trading price. Marvell recommended to its shareholders to reject the offer. Marvell’s trailing price-to-earnings ratio is 15.93 and its forward price-to-earnings ratio 10.73. It has an operating margin of 17.86% and a profit margin of 18.13%.
About the author:
I fundamentally analyze every business from the top down.
In my personal life, I have a strong Jewish faith and enjoy playing Scrabble and entrepreneurship.